By A PRASANNAIn a unanimous decision, the monetary policy committee of India (MPC) kept policy rates unchanged in the December policy as per our expectation.

The stance was also retained as ‘calibrated tightening’, with one member voting to change the stance to neutral. The real action came in the inflation forecasts and post-policy comments by the governor and the deputy governor.

The committee slashed inflation forecasts by 110-130 bps in H2 of this financial year and by 60-70 bps for H1FY20.

Notably, the extent of revision was still less than what the MPC carried out between April and June 2017.

In contrast to last year, the revisions this year have been wholly on the basis of unusually low food inflation and falling oil prices, even as core inflation has remained high and sticky.

Needless to say, such low inflation forecasts raised the question of why the policy stance is indicative of tightening. The question was answered in the postpolicy press conference where the governor said that should upside risks fail to materialise, then space will open up for commensurate policy action in the coming months.

Even though the RBI’s projection for Q4FY19 at 3.2 per cent is at the lower end of plausible forecasts, the upper end is seen around 4 per cent.

Similarly for H1 next year, where RBI sees inflation at 4 per cent on an average, upside risks may extend to 50 bps higher.

Taken together, these upper bands do not justify a ‘tightening’ stance given that the repo rate is already at 6.5 per cent.

Thus barring any strong spike in oil prices or a rapid reversal in food prices, the MPC will look to change the stance to neutral after sifting through some more inflation prints.

Thus we see this likely stance change coming by April and do not rule out a move in February itself. As far as the rate action goes, our base case is of a prolonged pause for the next six to 12 months, with the probability of a cut higher than that of a hike.

We see two reasons why the committee should not cut rates anytime soon.

One is that core inflation is still averaging above 6 per cent and even after excluding auto fuels and housing, it is averaging 5.2 per cent year to date.

Since core inflation reflects longer term inflation expectations, cutting policy rates when it is so far above 4 per cent would be counter- productive.

Second, with the MPC judging the output gap to be virtually closed and expecting growth to be around 7.5 per cent next year, the risks to inflation could still be on the upside.

That is to say, the MPC would need to see downside risks to growth before it can cut rates.

That said, a one-off rate cut cannot be ruled out if the inflation projection is seen at or close to 4 per cent. Lastly, the press conference also contained another bonanza in the form of continued open market operation (OMO) purchases through the end of this financial year.

We infer that OMO purchases will total Rs 3 trillion (Rs 3 lakh crore) for the full year and this is over 75 per cent of the central government’s net borrowing for the year.

Thus even as there is a high probability of fiscal slippage this year, the 10-year bond yield could come down to 7.25 per cent with possibility of a further downside.

This raises the issue of mispricing in the bond market but perhaps that’s an issue to be tackled later.